Days are gone when cryptocurrency was seen as a fringe currency only suitable for criminal activity. The asset class is now more legitimate in the eyes of the public (and some governments) more than ever. Some employers now pay employees with cryptocurrency, plenty of merchants now use cryptocurrency for transactions, and millions hold the e-currency as a digital store of value.
As the asset class has risen in popularity, the internal revenue service (IRS) has also started to pay closer attention and has recently taken to clarify how cryptocurrency should be taxed. This is so far as to send warning letters to thousands of crypto holders and investors who it deems to not have complied with crypto tax regulations.
Many crypto traders and investors are still in the woods when it comes to how to properly handle their crypto tax. This article clears some of the confusion surrounding the issue, as well as outlining instances in which you need to declare your crypto tax returns.
Cryptocurrency and Taxes: The Fundamentals
The IRS views and treats cryptocurrency as property – not as currency. The purpose of this is to make crypto taxable, just like other types of property, and it applies to all cryptocurrencies; Bitcoin, Ethereum, Bitcoin Cash, Litecoin, XRP, and so on.
This means that cryptocurrency must be treated by its owners just as they would any other form of property such as stocks, bonds, commodities, real estate, etc. As such, just as you would report capital gains and losses from stock trading, so should you report crypto trades. Failure to file your crypto returns is considered fraud by the IRS.
Bitcoins Held As Capital Assets Are Taxed As Property
The IRS treats cryptocurrency as property, which means tax principles for property apply. Thus, any profit gained or losses accrued should be taxed as either capital gains or losses. It’s’s just like selling your home or moving stocks.
Calculating Your Capital Assets
You take your cost basis – the amount you paid for the currency – and calculate how much it’s’s gone down since that date. Capital gains rates for a tax year can be 0, 15, or 20%.
However, if you’re selling property as part of a trade, it will not be considered as a capital asset and is taxed as ordinary income. This applies to cryptocurrency too. The IRS will look at the ‘character’ of the gain or loss, or, the intent behind your selling.
Cryptocurrency and Employment
Cryptocurrency used to pay for goods and services is also taxable. Employers paying wages in Bitcoin or any other cryptocurrency should also declare those earnings on W-2 forms. The cryptocurrency value should be converted to the equivalent value in US dollars on the date the payments are made, and careful records made. Also, wages paid in crypto are subject to withholding tax, just like for dollar wages.
For their part, employees must report their wages earned in crypto as dollars. Also, if you’re self-employed, you must declare any gains accrued from crypto sales transactions. You must convert the crypto to dollars on the day they’re received, and record the figures as tax returns.
Cryptocurrency Mining and Taxes
Crypto miners, people who utilize computer resources to validate transactions and record them on the blockchain, must also report receipt of the currency as income.
The IRS says when a taxpayer successfully “mines” cryptocurrency and receives earnings from that activity, they must include it in their gross income after determining a fair market value of the cryptocurrency on the day they received it. If a Bitcoin miner is self-employed, his gross earnings minus allowable tax deductions are subject to self-employment tax.
Taxable Events for Crypto
A taxable event is an activity that triggers a tax reporting liability. Such an event triggers a capital gain or loss that must be reported.
The IRS specifies the following crypto-related events as taxable events:
- Trading cryptocurrency to Fiat currency
- Trading cryptocurrency to cryptocurrency (you have to calculate the value of the trade at the time of the trade)
- Paying for goods and services with cryptocurrency (calculate the fair market value for the trade at the time of the trade)
- Earning wages/ income/ salary in cryptocurrency (including from mining)
What is Not a Taxable Event?
Gifting someone with cryptocurrency
- Transferring cryptocurrency
- Buying cryptocurrency with USD (since you don’t realize gains from that)
What if You Lose Money Trading Cryptocurrency?
If you lost money while trading crypto, you can actually save money by filing those losses and save money on taxes. You can even strategically save money by selling crypto assets in which you have incurred losses, in a strategy known as Tax Loss Harvesting.
Short-Term and Long-Term Capital Gains
If you’ve held cryptocurrency for less than a year before selling or exchanging, you should pay short-term capital gains tax. This kind of tax is equal to the ordinary income tax rate. However, if you’ve held cryptocurrency for a period longer than a year without selling or exchanging, you’re liable to pay long-term capital gains tax.
As such, individuals can pay taxes at a lower rate than the ordinary income tax rate if they have held the cryptocurrency for more than a year. But this will limit the tax deductions that they can claim on long-term capital losses.
What Happens If You Don’t Pay Your Crypto Taxes?
It’s easy to think that given the anonymity or pseudonymity of cryptocurrencies and the decentralized and peer-to-peer nature of crypto transactions that the government has no way of knowing that you’re trading, selling or buying cryptocurrencies. That might have been true for a while, but the IRS already caught up.
Indeed, the IRS won a court battle against crypto exchange Coinbase, which required the exchange to turn over data (taxpayer ID, dates of birth, addresses, transaction records, and so on) of over 13000 customers.
There is also the fact that the blockchain is publicly available, meaning anyone can view transaction histories at any time. It only takes linking an address to a real identity and determining who the owner of a transaction is.
Choosing not to file your crypto transaction returns is a risky decision that can get you on the wrong side of the law and expose you to criminal prosecution.